Geithner and Bernanke to Decide Our Fate

U.S. Treasury Secretary Geithner and Fed Chairman Bernanke both showed in the past week how their policy decisions are tied to the U.S. domestic agenda and how little they care about causing an international asset price bubble.

Australian financial market insomniacs would have had a chance in the past week to view live senate hearings on cable television networks into the reappointment of Ben Bernanke as Federal Reserve Board Chairman. CNBC, one of those networks, also ran a lengthy interview with Treasury Secretary Timothy Geithner as part of its coverage of the Washington jobs summit called by President Obama.

A good deal of the interrogation of these two senior US economic policymakers was preoccupied with domestic policy and political point scoring. However, answers to two questions highlighted their roles in setting the scene for Australian investors in the year ahead.

Geithner was asked whether the biggest risk for the US economy was the possibility of economic stimulus being withdrawn too early. He shot back swiftly that there was no such risk. Stimulus would be maintained for as long as it was needed, he asserted.

Geithner left little doubt in his discussion of the U.S. economy that he wanted to see a meaningful improvement in U.S. labour market conditions before there was going to be any change in the direction of policy.

This seemed to mean, on his analysis, that the administration would prefer to risk losing control of an economy expanding too rapidly than end up lumbered with one not expanding fast enough.

Coincidentally, on Friday, the U.S. Department of Labor reported that the US economy shed 11,000 jobs in November. The better than expected number still implied rising unemployment. The numbers also showed that the labour force itself continued to contract suggesting that the unemployment rate was being artificially held back by potential workers giving up the search for jobs rather than choosing to identify themselves as unemployed.

That said, if the rate of improvement in recent months was to be sustained, U.S. employment could well be growing for the first time in two years during December (and not simply contracting at a slower pace).

Nonetheless, that leaves the US heading into 2010 with a 10%-plus unemployment rate and considerable disquiet among the politicians in Washington about their electoral prospects. Against this background, the US administration will almost certainly maintain the bias in its policies toward stimulus for most of the coming year.

One of the criticisms levelled against the Fed as it attempts to stop the pool of unemployed growing any larger is that low interest rates are creating a liquidity bubble potentially stoking asset price inflation around the world. One indicator of this is a whole range of raw material commodity prices which belie a global economy battling to extricate itself from recession.

Fed Chairman Bernanke was questioned on how he felt about these outcomes but showed little remorse. He made his view abundantly clear. U.S. authorities, including the Fed, make policy to satisfy U.S. needs without regard to the impact on other countries. If U.S. interest rates happen to be too low for the comfort of other countries (e.g. China and Europe), those countries should adjust their policies (and allow their currencies to appreciate) to compensate.

At some stage, U.S. labour market conditions will improve enough for the stimulus (especially the monetary component) to be wound back. When that starts to happen, Australia faces the possibility of a sudden reversal of circumstances which have helped support growth here.

There was a taste of that on Friday night. As soon as traders thought that labour market conditions might improve more quickly than they had anticipated, they began to unwind the "sell the dollar/buy emerging markets and commodities" trade which had dominated markets in recent weeks.

In this context, Australia is assumed to be an emerging market proxy which should be sold. How long Australia can sustain its relative economic strength will depend on Bernanke and Geithner. How quickly Australia changes pace and how easily it makes the transition will also depend on Bernanke and Geithner.

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